LITHIA MOTORS INC annual report, FY2015

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Lithia Motors, Inc. — 2015 Form 10-K

Reporting period: Fiscal year ended December 31, 2015. This is an annual filing, not a standalone fourth-quarter report. Amounts below are in U.S. dollars.

Business context and reporting period

Lithia operates franchised new-vehicle dealerships and sells used vehicles, parts, service, financing and related products. At year-end it had 137 stores across 15 states and offered 31 new-vehicle brands; by February 26, 2016, it reported 139 stores. The business reports Domestic, Import and Luxury segments.

Growth was materially affected by the October 2014 acquisition of DCH Auto Group’s 27 stores. In 2015, Lithia acquired six stores and one franchise and opened one store.

Financial and operating performance

  • Revenue: $7.864 billion, up 45.9% from $5.390 billion in 2014. New-vehicle revenue was $4.552 billion; used retail, $1.927 billion; finance and insurance, $283.0 million; and service, body and parts, $739.0 million.
  • Profit: Gross profit was $1.176 billion, up 42.8%. Operating income was $302.7 million, up 30.6%. Income from continuing operations was $183.0 million, up 35.0%; diluted continuing-operations EPS was $6.91 versus $5.14.
  • Margins: Gross margin declined to 14.9% from 15.3%; operating margin declined to 3.8% from 4.3%. SG&A was 69.0% of gross profit, versus 68.4%. Management reported adjusted same-store throughput of 51% and targeted 45%–50% for 2016.
  • Business-line trends: Same-store new-vehicle revenue grew 8.9%, but gross profit per new unit fell 1.9% and gross margin declined 20 basis points to 6.2%. Same-store used-retail revenue rose 13.2%; used-retail gross margin fell 30 basis points to 12.9%. Same-store service, body and parts revenue grew 10.3%, with gross margin improving to 49.0%.
  • Fourth quarter: Revenue was $1.993 billion, compared with $1.793 billion in fourth-quarter 2014; net income was $47.7 million versus $41.1 million, and diluted EPS was $1.80 versus $1.56.
  • Cash flow: Operating cash flow was $74.2 million, up from $30.3 million. Management’s adjusted operating cash flow measure, including specified floor-plan financing adjustments, was $184.8 million, down from $213.3 million. Investing activities used $169.7 million, including $83.2 million of capital expenditures and $71.6 million of acquisition payments. Financing activities provided $110.6 million.
  • Liquidity: Cash was $45.0 million; working capital was $288.0 million. Cash plus available credit was $179.1 million. Including estimated borrowing capacity against unfinanced real estate, management estimated total available funds of $337.7 million; real-estate capacity is an estimate, not committed liquidity.
  • Debt: Total debt, including floor-plan financing, was $1.959 billion, up from $1.820 billion. Floor-plan debt was $1.314 billion; other debt was $645.4 million. Debt to total capital excluding floor-plan notes was 43.8%, down from 48.8%. Approximately 84% of total debt was variable rate, including the effect of swaps. The company reported compliance with its credit covenants at year-end.
  • Capital returns: Dividends declared totaled $0.76 per share for 2015, versus $0.61 in 2014. Lithia repurchased 306,386 shares during 2015.

Material changes versus 2014

  • Revenue rose sharply, largely reflecting a full year of DCH operations after its 2014 acquisition; same-store new-vehicle revenue increased 8.9%.
  • New-vehicle and used-retail unit volumes increased, but per-unit new-vehicle gross profit and vehicle gross margins remained under pressure. Management cited internet price transparency and its volume-oriented market-share strategy.
  • Service, body and parts continued to grow, supported by a larger population of late-model vehicles and increased warranty work, including manufacturer recalls.
  • Other interest expense increased to $19.5 million from $10.7 million, primarily due to higher borrowing and mortgage balances. Reported operating margin also reflected integration of DCH and non-core charges.
  • Year-end cash increased to $45.0 million from $29.9 million, while inventory rose to $1.471 billion from $1.250 billion. Reported operating cash flow improved, though the company’s adjusted measure declined.

Outlook, commentary, risks and unusual items

  • Management targeted same-store throughput of 45%–50% in 2016, aimed to increase used retail sales from an annualized average of 62 units per store per month toward 75, and expected approximately $100 million of 2016 capital expenditures.
  • The 2015 results included an $18.3 million charge for a transition agreement with Executive Chairman Sidney B. DeBoer; $16.5 million of impairment charges on a New Markets Tax Credit equity-method investment; and $3.6 million of long-lived asset impairments. The investment also generated $30.8 million of tax benefits and credits. Reported effective tax rate was 30.3%; excluding specified tax credits and non-core items, management calculated 38.4%.
  • Key risks include cyclical consumer demand, local-market concentration (the top three states generated about 53% of revenue), competition and vehicle-margin pressure, reliance on manufacturers and franchise agreements, acquisition integration, consumer credit availability, and environmental, regulatory and cybersecurity exposure.
  • About 84% of total debt was variable rate; management estimated that an 18-basis-point increase would raise annual interest expense by approximately $1.8 million, net of tax, based on year-end balances. Liquidity also depends on continued credit-facility access and the ability to finance real estate.
  • Two shareholder derivative suits filed in Oregon alleged fiduciary-duty breaches and corporate waste related to the DeBoer transition agreement. The company said it did not expect a material adverse effect but could not predict the outcome. A separate FTC settlement in January 2016 required specified disclosures concerning used vehicles with open safety recalls; Lithia made no payment and admitted no wrongdoing.
  • KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. The 2015 internal-control assessment excluded six stores acquired during the year.

Important facts for investors to verify

  • How much of 2015 growth and future performance depends on DCH integration, acquired-store returns and continued acquisition activity.
  • Whether same-store throughput, used-vehicle unit targets and the 2016 capital-expenditure plan are achieved without further margin deterioration.
  • Debt maturities, covenant headroom, availability under the revolving facility, and sensitivity to higher interest rates.
  • The sustainability and timing of New Markets Tax Credit benefits, remaining investment obligations, and any further impairment or tax-valuation adjustments.
  • Developments in the DeBoer-related litigation, franchise approvals and manufacturer relationships, and any material environmental, regulatory or recall-related liabilities.